Reading the gas pump numbers

Sep 28, 2006

What the hell is going on here? Just six weeks ago, gasoline prices at the pump were hovering at the $3 per gallon mark; today, they're inching down toward $2 -- and some analysts predict even lower numbers before the November elections. The sharp drop in gas prices has been good news for consumers, who now have more money in their pockets to spend on food and other necessities -- and for President Bush, who has witnessed a sudden lift in his approval ratings.

Is this the result of some hidden conspiracy between the White House and Big Oil to help the Republican cause in the elections, as some are already suggesting? How does a possible war with Iran fit into the gas-price equation? And what do falling gasoline prices tell us about "peak-oil" theory, which predicts that we have reached our energy limits on the planet?

Since gasoline prices began their sharp decline in mid-August, many pundits have attempted to account for the drop, but none have offered a completely convincing explanation, lending some plausibility to claims that the Bush administration and its long-term allies in the oil industry are manipulating prices behind the scenes. In my view, however, the most significant factor in the downturn in prices has simply been a sharp easing of the "fear factor" -- the worry that crude oil prices would rise to $100 or more a barrel due to spreading war in the Middle East, a Bush administration strike at Iranian nuclear facilities, and possible Katrina-scale hurricanes blowing through the Gulf of Mexico, severely damaging offshore oil rigs.

As the summer commenced and oil prices began a steep upward climb, many industry analysts were predicting a late summer or early fall clash between the United States and Iran (roughly coinciding with a predicted intense hurricane season). This led oil merchants and refiners to fill their storage facilities to capacity with $70-80 per barrel oil. They expected to have a considerable backlog to sell at a substantial profit if supplies from the Middle East were cut off and/or storms wracked the Gulf of Mexico.

Then came the war in Lebanon. At first, the fighting seemed to confirm such predictions, only increasing fears of a region-wide conflict, possibly involving Iran. The price of crude oil approached record heights. In the early days of the war, the Bush administration tacitly seconded Israeli actions in Lebanon, which, it was widely assumed, would lay the groundwork for a similar campaign against military targets in Iran. But Hezbollah's success in holding off the Israeli military combined with horrific television images of civilian casualties forced leaders in the United States and Europe to intercede and bring the fighting to a halt.

We may never know exactly what led the White House to shift course on Lebanon, but high oil prices -- and expectations of worse to come -- were surely a factor in administration calculations. When it became clear that the Israelis were facing far stiffer resistance than expected, and that the Iranians were capable of fomenting all manner of mischief (including, potentially, total havoc in the global oil market), wiser heads in the corporate wing of the Republican Party undoubtedly concluded that any further escalation or regionalization of the war would immediately push crude prices over $100 per barrel. Prices at the gas pump would then have been driven into the $4-5 per gallon range, virtually ensuring a Republican defeat in the mid-term elections. This was still early in the summer, of course, well before peak hurricane season; mix just one Katrina-strength storm in the Gulf of Mexico into this already unfolding nightmare scenario and the fate of the Republicans would have been sealed.

In any case, President Bush did allow Secretary of State Condoleezza Rice to work with the Europeans to stop the Lebanon fighting and has since refrained from any overt talk about a possible assault on Iran. Careful never explicitly to rule out the military option when it comes to Iran's nuclear enrichment facilities, since June he has nonetheless steadfastly insisted that diplomacy must be given a chance to work. Meanwhile, we have made it most of the way through this year's hurricane season without a single catastrophic storm hitting the U.S.

For all these reasons, immediate fears about a clash with Iran, a possible spreading of war to other oil regions in the Middle East, and Gulf of Mexico hurricanes have dissipated, and the price of crude has plummeted. On top of this, there appears to be a perceptible slowing of the world economy -- precipitated, in part, by the rising prices of raw materials -- leading to a drop in oil demand. The result? Retailers have abundant supplies of gasoline on hand and the laws of supply and demand dictate a decline in prices.

Finding Energy in Difficult Places

How long will this combination of factors prevail?

Best guess: The slowdown in global economic growth will continue for a time, further lowering prices at the pump. This is likely to help retailers in time for the Christmas shopping season, projected to be marginally better this year than last precisely because of those lower gas prices.

Once the election season is past, however, President Bush will have less incentive to muzzle his rhetoric on Iran and we may experience a sharp increase in Ahmadinejad-bashing. If no progress has been made by year's end on the diplomatic front, expect an acceleration of the preparations for war already underway in the Persian Gulf area (similar to the military buildup witnessed in late 2002 and early 2003 prior to the U.S. invasion of Iraq). This will naturally lead to an intensification of fears and a reversal of the downward spiral of gas prices, though from a level that, by then, may be well below $2 per gallon.

Now that we've come this far, does the recent drop in gasoline prices and the seemingly sudden abundance of petroleum reveal a flaw in the argument for this as a peak-oil moment? Peak-oil theory, which had been getting ever more attention until the price at the pump began to fall, contends that the amount of oil in the world is finite; that once we've used up about half of the original global supply, production will attain a maximum or "peak" level, after which daily output will fall, no matter how much more is spent on exploration and enhanced extraction technology.

Most industry analysts now agree that global oil output will eventually reach a peak level, but there is considerable debate as to exactly when that moment will arise. Recently, a growing number of specialists -- many joined under the banner of the Association for the Study of Peak Oil -- are claiming that we have already consumed approximately half the world's original inheritance of 2 trillion barrels of conventional (i.e., liquid) petroleum, and so are at, or very near, the peak-oil moment and can expect an imminent contraction in supplies.

In the fall of 2005, as if in confirmation of this assessment, the CEO of Chevron, David O'Reilly, blanketed U.S. newspapers and magazines with an advertisement stating, "One thing is clear: the era of easy oil is over... Demand is soaring like never before... At the same time, many of the world's oil and gas fields are maturing. And new energy discoveries are mainly occurring in places where resources are difficult to extract, physically, economically, and even politically. When growing demand meets tighter supplies, the result is more competition for the same resources."

But this is not, of course, what we are now seeing. Petroleum supplies are more abundant than they were six months ago. There have even been some promising discoveries of new oil and gas fields in the Gulf of Mexico, while -- modestly adding to global stockpiles -- several foreign fields and pipelines have come on line in the last few months, including the $4 billion Baku-Tbilisi-Ceyhan (BTC) pipeline from the Caspian Sea to Turkey's Mediterranean coast, which will bring new supplies to world markets. Does this indicate that peak-oil theory is headed for the dustbin of history or, at least, that the peak moment is still safely in our future?

As it happens, nothing in the current situation should lead us to conclude that peak-oil theory is wrong. Far from it. As suggested by Chevron's O'Reilly, remaining energy supplies on the planet are mainly to be found "in places where resources are difficult to extract, physically, economically, and even politically." This is exactly what we are seeing today.

For example, the much-heralded new discovery in the Gulf of Mexico, Chevron's Jack No. 2 Well, lies beneath five miles of water and rock some 175 miles south of New Orleans in an area where, in recent years, hurricanes Ivan, Katrina, and Rita have attained their maximum strength and inflicted their greatest damage on offshore oil facilities. It is naive to assume that, however promising Jack No. 2 may seem in oil-industry publicity releases, it will not be exposed to Category 5 hurricanes in the years ahead, especially as global warming heats the Gulf and generates ever more potent storms. Obviously, Chevron would not be investing billions of dollars in costly technology to develop such a precarious energy resource if there were better opportunities on land or closer to shore -- but so many of those easy-to-get-at places have now been exhausted, leaving the company little choice in the matter.

Or take the equally ballyhooed BTC pipeline, which shipped its first oil in July, with top U.S. officials in attendance. This conduit stretches 1,040 miles from Baku in Azerbaijan to the Turkish Mediterranean port of Ceyhan, passing no less than six active or potential war zones along the way: the Armenian enclave of Nagorno-Karabakh in Azerbaijan; Chechnya and Dagestan in Russia; the Muslim separatist enclaves of South Ossetia and Abkhazia in Georgia; and the Kurdish regions of Turkey. Is this where anyone in their right mind would build a pipeline? Not unless you were desperate for oil, and safer locations had already been used up.

In fact, virtually all of the other new fields being developed or considered by U.S. and foreign energy firms -- ANWR in Alaska, the jungles of Colombia, northern Siberia, Uganda, Chad, Sakhalin Island in Russia's Far East -- are located in areas that are hard to reach, environmentally sensitive, or just plain dangerous. Most of these fields will be developed, and they will yield additional supplies of oil, but the fact that we are being forced to rely on them suggests that the peak-oil moment has indeed arrived and that the general direction of the price of oil, despite period drops, will tend to be upwards as the cost of production in these out-of-the-way and dangerous places continues to climb.

Living on the Peak-Oil Plateau

Some peak-oil theorists have, however, done us all a disservice by suggesting, for rhetorical purposes, that the peak-oil moment is… well, a sharp peak. They paint a picture of a simple, steep, upward production slope leading to a pinnacle, followed by a similarly neat and steep decline. Perhaps looking back from 500 years hence, this moment will have that appearance on global oil production charts. But for those of us living now, the "peak" is more likely to feel like a plateau -- lasting for perhaps a decade or more -- in which global oil production will experience occasional ups and downs without rising substantially (as predicted by those who dismiss peak-oil theory), nor falling precipitously (as predicted by its most ardent proponents).

During this interim period, particular events -- a hurricane, an outbreak of conflict in an oil region -- will temporarily tighten supplies, raising gasoline prices, while the opening of a new field or pipeline, or simply (as now) the alleviation of immediate fears and a temporary boost in supplies will lower prices. Eventually, of course, we will reach the plateau's end and the decline predicted by the theory will commence in earnest.

In the meantime, for better or worse, we live on that plateau today. If this year's hurricane season ends with no major storms, and we get through the next few months without a major blowup in the Middle East, we are likely to start 2007 with lower gasoline prices than we've seen in a while. This is not, however, evidence of a major trend. Because global oil supplies are never likely to be truly abundant again, it would only take one major storm or one major crisis in the Middle East to push crude prices back up near or over $80 a barrel. This is the world we now inhabit, and it will never get truly better until we develop an entirely new energy system based on petroleum alternatives and renewable fuels.

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